Lecture Financial risks management - Topic 6: Currency forwards

Financial Risk Management 1 Topic #6: Currency forwards, futures, and Options L. Gattis Learning Objectives 2 Students understand and can recall Payoffs and profits of currency forwards, futures, and options Forecasting spot and forward exchange rates with PPP, IRP, and UFR How financial managers use forwards, futures, and options to hedge fx risk Forwards 3 Forward contracts are negotiated between parties (OTC), the terms include Currency pair, Quantity, Price, Delivery date and location Physical delivery or cash settlement Physical: Deliver or Take Delivery of Physical Currency. The majority of currency forwards are physical settlement. Cash Settlement: USD payment based on final spot exchange rate. Positions: Long (buyer of fx, takes delivery, gains if price increases, also called buyer) and Short party (seller of fx, make delivery, gains if price falls, also called seller) Usually requires no upfront payment if between two highly rated financial institutions A margin “Security deposit” may be required if your credit is worse than your counterparty Example: 10% Initial Margin, Forward Price=$1.25, Q=100,000 euros: Margin = .1*1.25*100,000=$12,500 (USD Margin = IM% x F0 (Direct) x Qty of Forex) Profits Long Forward Payoff (and Profit) = (ST­F0,T)xQ Short Forward Payoff (and Profit) = (F0,T­ST)xQ EURUSD Forward Quotes (Bloomberg) 4 Positions and Hedging 5 Hedging is the taking of a position that offsets an existing position. Asset Examples Expect to receive euros in 3­months (accounts receivable) Holding yen cash London real estate you expect to sell this year Own Shares of Novo Nordisk (Danish Stock) Is your exposure to an appreciating or depreciating dollar? How can you hedge? Liability Examples Kroner accounts payable Swiss denominated bond ... - tailieumienphi.vn